Firm size is consistent
with this structure, with a few large firms in the telecom, software
and harware sectors. Although there are a lot of smaller software
firms, I have classified these as Designers. The software that the
web is based on is in effect controlled by a few large firms such
as Microsoft, Adobe, Macromedia etc.
As traditional economic
theory would suggest with an oligopolistic situation, there are
a few medium sized firms who compete heavily with each other and
use externalities such as advertising to gain market share. This
can be seen from the predominance of hosting and ISP adverts in
computer magazines, search engine advertising on television etc.
Search engines are particularly interesting as they do not have
an obvious product to sell. They operate a free service to end consumers,
perhaps even seen as a public good on the internet. Their reliance
on advertising means that selling advertising space on the internet
iteslf becomes an oligopolistic industry. As they are now on the
whole only accepting listings for a fee this public goof has disappeared
and the internet is becoming a less dynamic place as new sites are
stifled through a lack of visibility.
The smaller mass
of dot coms and web designers are operating in a more perfectly
competitive market where traditional supply and demand determines
price. We will explore the evidence for this such as barriers to
itself can be a symptom of the maturity of the industry. Here too
the monopolistic firms tend to be long standing players in other
similar markets before the new economy came along. Many of these
will even claim to have created the new economy themselves, or at
least now have a pivotal and undeniable role in maintaing it.
One question is
whether in future consolidation in market segmentation will be seen.
For instance, will we see bigger internet design houses. Traditional
economic theory would see this in terms of vertical and horizontal
integration. In terms of the new economy I would argue we can expand
this further. Horizontal integration will be a symptom of the maturity
of the industry and will happen at the point where competition over
web design and dot com business becomes less perfect, the possibility
of this we will also need to discuss. If horizontal integration
is not possible this will restrict the size that these small firms
can become and therefore they will remain risky propositions In
this case vertical integration becomes more essential for survival
The market structure
that firms experience when operating in the 'new economy' results
in the large number of creative and knowledge industry firms having
to coexist with the monopoly and oligopoly suppliers who provide
the infrastructure for the industry. One response that government
policy can make to assist with the development of the new economy
is to provide a local business community which encourages collaboration
between small firms specialising in differrent sectors. A shared
cost approach may then allow these firms to deal with multinational
suppliers in a way that would not be possible without government
The government role
is primarily one of providing inter-firm co-ordination. As Michael
Best wrote in The New Competition; "Inter-firm
co-ordination cannot be explored in terms of the traditional hierarchy
or market dichotomy, allowance must be made for consultative co-ordination
or co-operation amongst mutually interdependent firms each of which
specialises in distinct form of the same production chain".
In other words, smaller firms need to be encouraged to develop strategic
alliances based on what distinct speciality they bring to the market.
In a knowledge driven economy, these type of strategic alliances
are required to provide small firms with a competitive advantage
through mutual problem solving. The fact that these firms are operating
at a time of rapid technological change provides their ability to
cope with big, more bureaucratic organisations.
At the same time
as making small firms more competitive in the new economy, strategic
partnerships can reduce the risk that these entities face, in particular
when considering the problems faced when encouraging new investment.
Co-ordination between companies at different levels of the hierarchy
in our market structure model reduces vulnerability to obsolesence
as it becomes less likely that a superior product or service can
be suddenly introduced which destroys the business model of one
of the strategic partners. In effect time is bought for the inter-firm
co-ordination to prepare a response to technological change.
However there is
one key element that is required to allow for strategic partnerships
to operate in this way, effective supply chain management. Many
dot com companies failed through their inability to fulfill customer
requirements. Market co-ordination across firms is unlikely by itself
to produce an effective supply chain as most customers will only
wish to deal with one party. Therefore government policy in this
area also needs to deliver a cost effective solution that encourages
supply chain management amongst the smaller firms in the new economy.
The nature of
According to Piore
& Sable, competitiveness depends on the institiutions within
that particular sector of the economy, what they call the "extra-firm
infrastructure". As we have already suggested we see a role
for government for providing the environment for this infrastructure
to develop to encourage a competitive new economy.
The current state
of competition would seem to be fairly predictable through standard
economic theory. With web development firms, there has been a first
mover disadvantage that has to be balanced against their attempts
to gain market leadership in their specialism. In new technologu
the first mover bears the risks of cost and unreliability of product.
There is a strong risk to these firms of free rider firms emerging
that can overtake their initial market leadership. Therefore there
was a strong incentive for them to concentrate on creating barriers
to entry through heavy concentration on advertising rather than
product development or customer service. This is the root cause
of the failures of the early dot com companies. They ultimately
failed not because the cash ran out before they could dominate the
market, but that the market itself had not yet emerged that they
could dominate. They may have been better to have concentrated on
developing a customer base through innovation and customer service
rather than trying to create barriers to entry, but it is too easy
to conclude this with hindsight. Joseph Schumpeter's description
of the process of creative destruction would seem to descibe this
situation perfectly with the ability to copy ideas and technology.
However, one must add that the destruction appeared to have more
impact on the emerging market rather than the traditional retailing
it was meant to destroy, something that Schumpeter didn't consider.
also exists in the new economy to an unusual extent. Consumers are
unwilling at the current time to pay for web based services on the
whole. Individuals appear to expect something for nothing on the
internet. The ability to transfer technology from one application
to another has resulted in nearly as good services and software
being available for free, destoying the business plans of many dot
Returning to our
original market structure model, the monopoly suppliers are making
monopoly profits in the new economy in supplying the background
infrastructure. The small firms are surviving or falling depending
on their success in making money out of this competitve market,
but 50% at least are making money at any one point in time. It is
the oligopoly firms that struggle with the current model in the
new economy. The concept of non-price competition outlined by Schumpeter
is clearly important here. The firms such as content providers,
advertising agencies and search engines are now trying to work together
more on a strategy for the sector rather than competing on an individual
company basis. Whether they will be able to maintain this attempt
at income generation is doubtful. The amount they would need to
spend to create a big enough barrier to entry to extract significant
subscription income from the end consumer is probably too large
to justify the investment. It may be that public policy will be
required to intervene and to treat these services as public goods
rather than competing firms in an open market.
Culture of the
Firms in the new
economy are developing their own culture as the industry develops.
The more traditional parts of the industry such as software, telecoms
and retailers tend to exhibit the same culture they would had before
an on-line economy developed. New media firms and designers however
have developed their own style of operation independently from this.
Again this can be seen in terms of firm and market size that they
are operating in.
The larger firms
have to operate to a system of industry standards, which directly
affects their culture and the way they behave. A consistency of
approach is required for software developers and hardware manufacturers
so as to encourage inter-operability of their products. The monopoly
firms in the industry, such as Microsoft are frequently the standard
setting body for other dependent firms, a position that drives much
of the potential anti-trust action against them. Like many other
monopoly and oligopoly suppliers in other industries, there is a
tendency to over production as a result of their position in the
market due to the high fixed costs caused by creating the barrier
to entry that such industry standards in effect are (although this
is not an argument against the potential economic benefits that
standards themselves generate - there is clearly a difference between
open and proprietary standards with open encouraging entry and proprietary
restricting it - in either case the way the firm acts in creating
these standards is the same).
Firms in the new
economy can also be distinguished between those that operate on
a hierarchical basis and those that operate on a knowledge basis.
The hierarchical firm attempts to create control over the market
and its external environment through dominance. The knowledge firm
attempts to participate and contribute to a market through the development
of strategic alliances on a complimentary basis. In theory the hierachical
firm should be controlled in its actions over the market through
anti-trust and other forms of market regulation. However with new
technology areas the rules set by regulators cannot keep up with
industries that by their nature are evolving and do not develop
along traditional lines.
The new economy
is often described in terms of having a 'youthful' culture. Economists
would not be suprised at this if they went along with Marshall description
that "Firms, like trees, gradually lose vitality, and one after
another they give place to others, which ....... have on their side
the vigour of youth". This is more a bioloigical theory of
the firm than Schumpeter's procees of creative destruction. It almost
implies that the death of the current culture in the new economy
is almost certain as the firms themselves mature; that the industry
becomes less exciting and more 'traditional'. This would seem unlikely,
unless this is driven by a change to the market structure and small
firms combine to produce large international firms of web designers,
who proceed to be less knowledge and more hierarchically based.
As mentioned before vertical integration would appear unlikely in
the new economy even in the longer term as it would result in the
creativity within the industry and the role of the entrepreneur
emerged originally through the idealism of a few individuals. The
big companies of the new economy still tend to have a leading light
or figurehead at the helm whose identity is rarely separable from
the firm, Bill Gates at Microsoft for instance. As described by
Coase, in perfect competition price movements decide production,
the equivalent of technological developments in the new economy.
However in firms the entrepreneur-coordinator directs production.
Firms emerge because of uncertainty and risk. As we have questioned
before it is important in the new economy in particular to what
degree is risk shared through strategic alliances. By and large
this can also be interpreted as to how much the firms taking part
in such an alliance share information between them, this not being
just about trust in the partnership but a case of sharing information
being an indicator of sharing risk.
would be significantly different from Joan Robertson's description
of firms being "islands of unconscious power in the ocean of
unconscious cooperations like lumps of buttermilk coagulating in
a pail of buttermilk." Sharing risk requires cooperation between
individual entrepreneurs to be made in awareness of the effect they
are having on the overall market. This is not just true for oligopolistic
firms who by nature attempt to limit competition in their sector
of an industry (through barriers to entry for instance) but is equally
as true for the small firm operating in a local market. The question
is more of whether the small firms operate in this way through necessity
or through compulsion, due either to government industrial policy
or through the actions of the bigger firms in an industry. One example
of this would be re-seller network, where big firms avoid direct
sales to small and medium sized enterprises (SMEs) through a partnership
network of smaller firms who reduce the administrative burden of
selling direct. This does however have a price and dependence cost
on the SME who wishes to take advantage of new technology, something
that government industrial policy is attempting to tackle after
the event rather than through establishing an industrial policy
through the small new economy firms directly.
An industrial policy
that encourages competitive and cooperative entrepreneurialism in
a local business district would still contain the problem of power
relations between the participants in strategic alliances. However
it would develop some form of community that would develop its own
culture and informal rules which would allow the positive externalities
of the market to coexist with the entrepreneurial nature of each
the new economy
how strategic alliances are used to put structure to the role of
the entrepreneur in the new economy, we need to consider how innovation
and change develops within the new economy and how this impacts
the economy as a whole. Schumpeter distinguished between price competition
and the process of creative destruction which forms new markets
within the whole of an economy. He defined this process of creative
destruction as being the "process of industrial mutation that
incessantly revolutionizes the economic structure from within, incessantly
creating a new one." This implies that innovation may be the
key to the new economy, rather than a process that produces greater
efficiency of exchange (and hence price competition) in the economy
as a whole. This helps to explain why the market structure involved
in the new economy exists and why this will not result in the certain
destruction of monopolies and oligopolies such as Microsoft.
The firm in the
Schumpeter analysis is an agent of change within the economy, whilst
the entrepreneur is the source of ideas that bring change about.
This again provides support for a role for an industrial policy
in encouraging the conversion of ideas into firms and firms into
business communities. The key to developing the new economy is how
far can the single entrepreneur with an idea effectively turn this
into a successful and sustainable firm.
that are active in the new economy are likely to be obsessed with
the growth and development of the firms rather than price competition
and profit maximisation for its own sake. Many new firms beleive
that there idea has a perceived value and benefit that shouldn't
be devalued through price negotiation. The concept of profit maximisation
itself can only be an abstract notion as the creative destruction
process brings about external disturbances to the competitive market.
This also explains
why many e-commerce firms will fail. In reality, the whole concept
of a new economy itself may be driven into extinction as the speed
of change renders business plans obsolete almost before they are
written. Venture capital may constrain entrepreneurial firms to
operate as profit maximisers in a market where this is a concept
that cannot exist. Rather than focussing on the idea, the innovation
, they are forced to focus on behaving like a firm in a mature industry
would. This is self-defeating. Penrose identified that firms are
limited to growth by the boudries of teamwork, based on their objective
and experiential knowledge. Innovation and the development of a
firm is a skill that entrepreneurs are unlikely to develop during
the start-up phase of a firm in the new economy. If venture capital
is unable to provide this assistance then there is a role for an
industrial policy for the new economy to achieve the same aim.
Survival in the
new economy also requires expansion to a certain extent. Firms will
only become profit maximisers as they progress up the market structure
and develop established niche and speciality areas that are of value.
The pressures of a firm from this type of development and expansion
are even greater as they begin to require beuraucratic control mechanisms
rather than the direct control the entrepreneurial firm tends to
exhibit. We again come back to the strategic alliances that were
discussed earlier. As Richardson identified, firms tend to internalise
similar activities and externalise complementary activities. If
firms in the new economy and the innovations they bring to market
are to thrive, they need to have recognised this in the way they
operate with both allies and competitors.
the way that firms have developed in the new economy, it is useful
to now revisit some of the market structure elements that have emerged
from this analysis. To what extent, for instance, can the new economy
be described as a productive system (of the type outlined by Best),
where a group of connected institutions through which goods and
services are created, resulting in the continuous improvement of
products and processes.
We have outlined
that small firms will continue to exist in the peripheral sectors
of the new economy, but it is from these type of firms that new
ideas tend to emerge. One of the problems that many of the new economy
creates for these firms is when they try to mimick market structures
of traditional industries too early in the business maturity cycle.
This tends to lead to high marginal cost and pricing structures
that limits the growth of the idea involved. At the other extreme
are firms that believe they can break completely with ideas of economics
and pricing which often has resulted in business models that were
unsustainable even in the short term (advertising led models for
free services are good examples of this).
The firms that claim
to provide the backbone to the new economy, the technology and infrastructure
provides, exhibit clear signs of traditional oligopolistic behaviour.
Non-price competition through heavy advertising and strategic alliances
all are used to justify the losses that these companies currently
make, on the basis that they will be in the short term whilst the
market matures. However, as Baumol, Panzar and Willig identified,
if all producers have access to the same technical and productive
characteristics their consumers will respond quickly to price changes,
yet the established firms cannot respond swiftly enough when a potential
entrant sets up for business at cheaper prices. Then in this case
barriers to entry will not be maintained. This would appear to make
sense as technology becomes cheaper as well as better. Galbraith
identified that oligopolies frequently were faced with oligopoly
customers, the idea of counterveiling power. The technological infrastructure
companies tend to be selling to the big multinationals and other
technology companies, therefore they may be unable to make excess
profits due to the market structure of the economy.
Most of the development
of the new economy can be explained through existing economics,
whether this is basic economics of supply and demand or elements
of industrial economics using the theories of firms and markets.
This does not mean that firms in the new economy should behave as
their traditional market contemporaries do, in particular they should
seek out strategic partnerships with complementary firms rather
than trying to control the supply chain through horizontal and vertical
integration. Such a focus on firm size is likely to reduce the creativity
of the industry as more bureaucratic forms of control are required.
For government policy
the encouragement of small business districts is not a new idea
and does not just apply to firms operating in the new economy. A
recognition that some elements of the internet and software markets
are public goods (such as search engines) will need to develop before
the new economy has a stable enough platform for its long term development.